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June 29— Significant changes in hedge accounting rules to be proposed by accounting rulemakers are expected to lead to a wider use of the special accounting prescriptions that accompany use of derivative instruments aimed at cutting risk.

The Financial Accounting Standards FASB voted June 29 to simplify complex hedge accounting prescriptions and lower some hurdles on qualifying for the business-friendly form of reporting.

At the same time, the board sought to hew to the basic principles and constraints underlying the use of the accounting blueprint in which derivatives play a key role. A main aim of FASB is to have hedge accounting rules “more closely mirror” companies’ risk management practices, a staff accountant told the board.

Financial, Nonfinancial Hedges

FASB's decisions at its weekly meeting encompassed both financial instruments and non-financial transactions, such as purchases of ingredients and materials for production and operations by non-bank companies.

The proposed changes by FASB are expected to have the deepest impacts on what are known as nonfinancial component hedges by corporations and, in the realm of financial instruments, on hedges of variable-rate instruments and on total coupon cash flows stemming from benchmark interest rates.

A FASB staff member described the total coupon topic as a pervasive issue in accounting under the key, long-standing generally accepted accounting principles on derivatives and hedging activities, Topic 815, formerly FAS 133.

The board's action on nonfinancial hedges would have the practical effect of making it newly possible to employ beneficial hedge accounting in taking on derivatives used to counter risk of changes in prices of ingredients or inventory items.

Sample situations commonly cited by board members include hedging against changes in crude oil as they relate to an airline's jet fuel stocks or a tire company's hedging against changes in rubber prices.

FASB hopes to issue by Dec. 31 a detailed exposure draft reflecting its decisions on changing the hedge accounting model.

Keeping Shortcut Method, With Less Penalty

Also at its June 29 meeting, the board voted to keep current GAAP's “shortcut method” of hedge accounting. It also supported effectively lessening the down-side effect if using the less burdensome alternative to ASC 815's “long-haul method” of hedge accounting wasn't or isn't appropriate.

FASB's tentative June 29 decision on the shortcut method means that a failed use of the shortcut method wouldn't necessarily disqualify a company or bank from the benefits of hedge accounting, as is the case under current rules.

Under ASC 815's rules for hedge accounting—deemed a special, or exceptional method by FASB—derivatives that prove to be highly effective at countering risk of changes in prices or losses in value don't have their gains and losses recorded earnings.

Highlights of June 29 Decisions

On the overall hedging model, which relates mainly to nonfinancial hedges, presentation and footnote disclosure, FASB's June 29 decisions include, according to staff-written background materials:

• eliminating the concept of hedging ineffectiveness;

• for all cash flow hedges meeting a threshold of being “highly effective,” changes in fair value of the hedging derivative would be recorded in other comprehensive income until the hedged item affects earnings;

• also on cash flow hedges, when reclassification in the income statement takes place, the change would be booked in the line item being hedged;

• for all fair value hedges under the highly effective threshold, the change in the fair value of the hedging derivative would be recorded in the income statement line item being hedged;

• for nonfinancial hedges, allowing the contractually specified components to be the hedged item; and

• specific disclosure requirements, including a revised table “that shows the effect of hedging on individual income statement line items” and “enhanced qualitative disclosures to describe quantitative goals, if any, set to achieve hedging objectives.”

Changes on Variable-Rate, Fixed-Rate Instruments

In other highlights, on financial instrument hedges, FASB supported an effective relaxing of the use of benchmark interest rates for hedges of variable-rate instruments.

In that circumstance, the board voted to permit the contractually specified index rate to be the designated interest-rate risk. The current benchmark rate definition wouldn't apply any longer.

FASB also moved to new territory on use of benchmark interest rates in hedging fixed-rate instruments. The municipal swap index of the Securities Industry and Financial Markets Association would be added to the list of benchmark rates already in use under GAAP.

On hedges of financial instruments, FASB plans to allow an entity “to designate the benchmark component of the total coupon cash flows attributable to the benchmark interest as the hedged item in a fair value hedge of interest rate risk,” as stated in the staff handout.

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